The Next Generation Of Insurance-Based Planning

Using the latest VUL innovations to help S Corporation owners

By Brett W. Berg and David K. Smucker

The recent rebound in the equity markets plus the recent nonqualified deferred compensation legislation has revived the ongoing opportunity to promote reviews of nonqualified savings plans for business owners. For example, it is appropriate for C corporations to review their existing deferred compensation plans and potential for life insurance as an informal funding vehicle. Or, if no deferred compensation plan exists, C corporations can consider implementing such a plan.

But what about S corporations? Many advisors are seeking marketing campaigns for S corporations because S corporation owners often cannot take advantage of traditional nonqualified deferred compensation because of the pass-through taxation of S corporations.

Of course, S corporation owners need to save, too. The current environment creates a tremendous opportunity to help S corporation owners understand their options for creating meaningful nonqualified savings plans, especially using variable universal life insurance (VUL) for long-term potential cash accumulation.

In general, such nonqualified savings plans may be funded by taking additional income from the S corporation such as bonuses. In addition, todays products include valuable innovations. Carriers are lowering the mortality and expense charges to bolster cash accumulation and creating income management tools to manage withdrawals and loans. This generation of product development focuses not only on accumulation, but also on helping advisors manage the retirement income phase of insurance-based retirement plans. The products and services are more turnkey financial vehicles for accumulating, distributing and transferring wealth.

The Problem and Opportunity for S Corporation Owners: Pass-Through Taxation

The general tax-planning concept for nonqualified executive benefit planning is that life insurance premiums are paid with after-tax dollars. Therefore, it is tax-efficient for premium payments to be made by the person or entity in the lowest tax bracket. Accordingly, a tax-planning opportunity exists when there is a difference between the life insurance owners income tax bracket and the tax bracket of the business he or she owns.

No such difference exists for S corporation owners. Basically, the S election results in pass-through tax treatment for the S corporation owners. For income tax purposes, the owners are taxed on all profits whether or not such profits are distributed. The lack of a separate corporate tax entity means that nonqualified deferred compensation and split dollar do not offer any income-tax planning advantages.

Of course, S corporation owners can and should implement qualified plans to save on a qualified basis. In addition to adopting a qualified plan, what are the nonqualified savings options for the S corporation owner?

Insurance-based Retirement Plans Funded by Bonuses

Essentially, S corporation owners have the same savings solutions as everyone else with respect to their after-tax income. One of those solutions is an insurance-based retirement plan funded with bonuses.

An insurance-based retirement plan is a popular savings option, especially using VUL. In such a plan, the S corporation owner personally owns the policy. The premiums are funded through bonuses. Of course, the S corporation owner pays tax on the bonuses and places either all or a portion of the after-tax amount into a VUL policy. Usually the VUL policy is designed as a minimum non-MEC type of plan to enhance the potential cash accumulation in the policy. At retirement, the S corporation owner may take withdrawals from the policy and/or policy loans to supplement retirement income. Assuming that the policy does not lapse and is not surrendered, such withdrawals and loans will not be subject to current income tax. In addition, if the S corporation owner dies, the death benefit is paid to his or her beneficiary.